To start off I thought we’d review the most important truisms of multifamily investing. The best known is: “Buy low, Sell high.” The second most important is: “The three most important considerations in real estate are 1. Location, 2.) Location, and, 3.) Location.” OK, heavy duh factor on those two. Today I want to focus on the third most important truism:
“You get paid most of your profits at the end, but you earn them at the beginning.”
It’s important to know your actual starting point. Due Diligence research is how you establish that. It’s how you know whether you’re looking at a cash cow or a profit-eating alligator.
Competent Due Diligence for investment real estate has three phases:
- Phase I: Preliminary Title Report
- Phase II: Books and Records
- Phase III: Physical Plant Inspections
Contact Rick Bean at 503.577.1034 or rick@rosecitycre.com for a review of your Due Diligence information…or any of your other real estate investment needs.
PHASE I DUE DILIGENCE: PRELIMINARY TITLE REPORT
This typically starts a few days after the opening of escrow. The title company issues a Preliminary Title Report. This will is a list of all items the title company shows that pertain to the Subject Property. That includes liens, easements, and deed covenant, conditions, and restrictions, more typically referred to as CC&R’s. This is a place where lazy agents do things that drive their E &O (error and omission) Insurance providers crazy. If there are liens, they must be paid off before the title can be transferred. And there may be items that are appurtenant with the land (run with the land) that any buyer needs to be aware of.
A Bridge to Nowhere: I was representing a buyer for a property that had a Skybridge attached to it. There was no easement agreement defining who had ownership of what parts, who was responsible for maintenance, and who was liable. My Buyer saw it as a poorly maintained eyesore, the Seller saw it as an asset with great long-term potential, the owner of the building it connected to considered it a problem and locked their side to prevent entry. This is a recipe for long-term litigation.
There were also 4 easements and 1 encroachment noted. Proper Due Diligence meant verifying where these were so that the Buyer knew before buying whether or not any of these could potentially compromise the value of the asset. The Preliminary Title Report in the example above also contained an erroneous finding. When I matched the findings to the list of reported items I noted that an item recorded as an encroachment was actually a note. In theory, if there was a problem the buyer might be able to sue the title company for satisfaction…but I put extra effort to avoid situations for my client where suing is the best option.
A Highway Through the Property: I represented a buyer in adding a 57 unit multifamily property to their existing billion-dollar portfolio of 7,000+ units. A thorough examination of the Preliminary Title Report showed that the entire property was subject to an easement for the State of Washington to build a freeway through it. This was placed on the property several decades before the property was built because the state knew a new highway would be needed in the future. Since the highway had already been constructed, we insisted that the seller work with us to remove that easement as a condition to closing to prevent problems in the future. We were shocked that the apartment builder had not been as diligent when they bought the property.
Bottom Line: In buying commercial real estate, an ounce of prevention is worth much more than a pound of cure.
Other articles you may be interested in:
Michael Kapnick: The way investment real estate ought to be done! | Rose City Commercial Real Estate
What You Need to Know about Capitalization Rate | Rose City Commercial Real Estate